“Something is rotten in the state of Denmark” is one of the signature lines from Shakespeare’s play Hamlet. I thought about that when I read a couple of recent articles in the New York Times (NYT), entitled “Questions Are Asked of Rot in Banking Culture”, by Peter Eavis and the Wall Street Journal (WSJ), entitled “Lawmakers Tell Justice Dept. to Seek Swiss Banker Extraditions”, by Joel Schectman. Eavis wrote that banks have been accused of money laundering, tax dodging, market rigging and rampant risk-taking; all of which I would add could lead to potential Foreign Corrupt Practices Act (FCPA) violations.

Banks would seem to have a different relationship with the public than energy companies. Eavis said that the “At the heart of the issue is an inviolate social contract that bankers are supposed to honor. The government agrees to protect banks from collapse, and in return, bankers are meant to uphold the highest ethics when handling other people’s money. But when law-breaking and other missteps proliferate at banks, it is a sign that the industry has stopped cleaving to the special contract, endangering taxpayers. And bad management can be a leading indicator of future financial problems at an institution.”

But more than this ‘social contract’ is regulators. The Department of Justice (DOJ) has never been shy about enforcing the FCPA against energy companies who violate the law. “Too Big To Fail” still resonates as an excuse for regulators who didn’t regulate so that they “may find it hard to convince the public that they mean business” this time around and on this issue. Eavis noted that William C. Dudley, president of the New York Fed and Thomas J. Curry, Comptroller of the Currency, have both recently spoken out about banks and their culture. But Eavis notes, “each had a reputation for being too soft on the banks.”

The regulators told Eavis that they are indeed ‘ratcheting up the pressure’ on banks. Curry was quoted as saying, “We are ratcheting up the potential consequences. This is something new.” Eavis properly asks that with some of the best legal talent money can buy for defense, who deploy strategies like refusing to turn over potential evidence to regulators” and simply having such large profits “they can easily absorb the financial penalties the government throws at them”.

Eavis notes that one continuing area of concern and an area of potential change is compensation. He states “compensation is one area where bank regulators may need to do more if they want to do more to clean up bank culture, according to critics of the industry.” This is because bank compensation practices “can reward unhealthy levels of short-term risk-taking and entice bankers into ethical lapses.”

While it is doubtful that banks would ever make changes similar to those made by GlaxoSmithKline PLC (GSK) to move away from compensation variably based upon sales to a straight salary; Eavis reports that regulators outside the US “agreed after the crisis to overhaul bankers’ pay, in part by requiring them to wait several years before they receive all of their bonuses. The hope is that bankers will behave better if they know their employers can easily take back the deferred part of their pay.”

The problem regarding compensation in US banks is that they “are still deferring much less pay than their European peers. The Fed is in charge of regulating compensation at American banks. When asked whether the pay overhaul at American banks had gone far enough, Mr. Dudley said, “There is potential to defer more compensation for longer periods of time.””

However, banks need more than simply a change in compensation to address their cultures. It really is about ethics. Interestingly this is where ‘Too Big To Fail’ comes into play. But Eavis also writes “Some banks may be so large and complex that it would be difficult for managers to maintain a clean culture across all of their operations.” Dudley was quoted as saying, “Either the firm is not too complex, you can manage it, you do know what’s going on,” he said. “Or, if you don’t know, that’s sort of raising the question whether the firm is too complex to manage.” This means “he would not allow size or complexity to be an excuse for ethical breaches.”

Although not directed at US banks and bankers, Senators Carl Levine and John McCain, who jointly lead the Senate’s Permanent Subcommittee on Investigations, channeled their inner Howard Sklar when they wrote a letter to the DOJ and urged them to “at least attempt” extradition proceedings against indicted Swiss bankers. They jointly said “Even if the extradition request is denied, it will inform both Switzerland and its citizens that the United States is ready to make full use of available legal tools to stop facilitation of U.S. tax evasion and hold alleged wrongdoers accountable.”

I felt the DOJ response was well reasoned when a spokesman said, “extradition proceedings would be a poor use of resources. Because aiding tax evasion is not considered a crime in Switzerland, the country is unlikely to honor U.S. extradition requests.” But John Carney, a former federal prosecutor who is now a partner at Baker & Hostetler LLP, believes that “an extradition request from U.S. authorities would be a powerful signal”. He was quoted as saying “It’s a shot across the bow for folks who think it could never happen,” Further, “The unsettling part for a potential defendant is the request is there and if the [Swiss] government ever changes its view, it’s one step closer to actually happening.””

I have written about Bankers Behaving Badly more than once. The litany of financial crimes they have admitted to goes on almost monthly. But when the government regulators start talking about a rotten culture; that seems to take things up a notch or two. Remember, I come from Houston, which is the epicenter of FCPA enforcement. I do not remember any government official or regulator talking about “deep-seated cultural and ethical failures” at energy companies in Houston. These public comments should certainly be a wake up call for senior management at these institutions. My advice would be to get your Chief Compliance Officer (CCO) in for a meeting ASAP and while you are at it, you may want to consider hiring a Chief Ethic’s Officer as well.

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